We’re hosting our weekly “The Retail Show” tomorrow, Monday at 11am. We’ll ‘speed date’ through our Position Monitor changes, upcoming earnings for the week, and any other questions that viewers (including you) put into the queue. Video Link CLICK HERE
Nike (NKE) | Booting from Best Idea Long List. This is a big call for us, as Nike has been on this list for years. But lately the stock has been treading water around $100, with fundamentals being questionable – which is being generous. I (McGough) have to say that when asked to pitch Nike as a long, by the time I'm done, it sounds like a short. The reality is that Donahoe was the worst CEO Nike has had outside of Bill Perez (who only lasted a year). Yes, he did some heavy lifting, but Nike has clearly lost its identity at a time where barriers to entry for upstart brands selling shoes have come down dramatically. He's an over-rated CEO. EBIT dollars have been flat for 4 years – ie ZERO incremental revenue flow through, and will only go up in the 5th year due to outsized SG&A cuts. Donahoe said 'I'm holding myself accountable, and am cutting employees’. [I'm paraphrasing]. The reality is that he should fire himself. With share in running going from 20% to 7% over 5 years, this company has simply gotten its clock cleaned in its two most important categories – the other being basketball – which is fine. On the plus side, we think Nike will launch a major running platform this year in conjunction with the Olympics, which keeps us marginally positive on the name (it's on our Long Bias list now), and it's protecting its gross margin while it opens up the spigot to sell more into wholesale (FL is the best play there – Best Idea Long). At the same time, it's got about $2bn in cost cuts on a gross basis, and likely $1bn net after reinvesting in partnerships, innovation, R&D and Marketing. The fact that Heidi O'Neill is likely to be the next CEO hardly inspires us. She's a softball (Yes Heidi – if you're reading this, I think you got the job because more qualified people have left the organization and you're all that's left). Note: I already have enough friends at Nike, and don't need the C-Suite to like me – which they don't – bc I speak my mind unlike the rest of the covering analysts. But this upcoming quarter should have an absolutely dreadful earnings algorithm, and my prior bull case was predicated upon $7 in EPS power over a TAIL duration, but unless the brand really starts to take off and regain share in running, this could be an $80 stock before it hits $120. Not a risk/reward I like near term, and not one I'm willing to backstop with a Best Idea designation. Too many up and coming long ideas – both inside US borders and outside – for us to build a balanced book. If we miss a $20 run in Nike on the upcoming product launch, I'll be comfortable adding back to Best Ideas at $120 – as it's likely a path to go to $200. But for now, I gotta be intellectually honest and put this name where it belongs. On the Bench.
Target (TGT) | Going Long TGT. TGT was a good short for us from Sep 2022 around $160 to Summer 2023 when we covered around $125. Now we think it’s time to go long. It was a solid quarter for TGT this past week putting up a nice EPS beat of $2.98 vs $2.42 expected, with rate of change improving. We’re putting TGT on our Long list as we see upside to earnings over a TREND and TAIL duration and a rate of change setup that should take the multiple higher over the next 6 to 12 months. TGT has some of the easiest compares in retail over the coming months given the impact of traffic from last year’s boycott (which looked to be temporary), and while still seeing margins running below normal and credit declining for the past 12 months. The company just laid out what we think is beatable guidance with the company still having some SG&A reduction plans from last year’s announced cost savings initiatives. When we match up earnings upside, with what should be accelerating revenue trends and margin expansion, that’s a recipe for multiple expansion and upward earnings revisions. Unlike other traditional retailers, with TGT market power and massive cash generation, we can argue a multiple into the high teens or low 20s if the business is accelerating. We think 2024 should beat by over a buck vs current street expectations, and over the longer term we see TAIL earnings of $14 to $15 with the street looking at closer to $12. That gets us to a stock of around $215 to $240 over the next 12 months, or 25% to 40% upside with solid downside protection.
Leslie’s (LESL) | Going Long – Adding to Long Bias List. TREND Setup is Excellent. Doing work on TAIL. We think Leslie’s, the largest pool and spa supply/care retailer in the US, has one of the best rate of change setups in all of retail and an idiosyncratic, product-driven story in its Accublue Home water test that will help to deliver a multi-year comp cycle, which will both drive earnings and the multiple higher over a TREND and TAIL duration. Since its 2020 IPO, this stock has been broken, but that’s what happens when a levered company at peak demand goes public. Now, after an abysmal 2023, in which demand for discretionary items, especially big-ticket ones like hot tubs, fell off a cliff and Trichlor (chlorine) price cuts took a whack to margins, the 4-quarter comp setup in both POD 1 (revenue growth) and POD 2 (margins) begets an acceleration. Looking forward, weather is reportedly normalized (though not really a factor in our model), hot tub forward order books stopped declining and customer interest is returning, prices are stabilized, and our US macro-outlook is improving and expecting multiple months of Quad 2 during LESL’s most seasonally important quarters. Not to mention, any improvement in home turnover from these trough levels would spur increased pool related spending, further driving the comp. Furthermore, the company’s proprietary Accublue Home water test, which allows members to test their pool quality on their own at home, is still in its initial adoption phase, but is already driving increased engagement, conversion, and basket, and is extending and strengthening customer relationships. As of now, Accublue members spend on average $1000 at Leslie’s per year, but we think this number can be higher, LESL can monetize the product better, and adoption will ramp once the value prop is fully realized. Over a TAIL duration, this could be a game changer, driving growth, margin, and further separating LESL from the pack. The street also expects an acceleration over the coming Q’s, but numbers are very beatable. We think 2024 will beat expectations, and that TAIL earnings will be closer to a dollar, about double what the street is looking for. On an accelerating growth and margin algo, we think the multiple should be closer to 25X, making this name good for more than a double. Keep in mind that this is viewed by most as a junky retail business given how it's performed since the IPO, but if you're in Private Equity, you've gotten a look at the books for the past 20 years – and you know that this is a far more defendable and growthy business than the last two years of results suggest. Again, we're doing more work here, but initially like it a lot – especially over the near-term. 13 % of the float is short, the Sell Side hates it, and earnings expectations are too low. We think this stock will work for us over 6-9 months as we do the work to determine whether it's a multi-bagger.
Arhaus (ARHS) | Removing From Short List. We had a solid short on ARHS with it on our Best Ideas Short list, taking it down to our Short Bias list around $8. Since, though, the short has not been correct despite the model going roughly as we thought. We kept ARHS on the short list expecting numbers to move lower and ugly rate of change trends as the company lapped satisfaction of the backlog last year. EBITDA estimates have come down about 10% over the last couple quarters, and the comp trends have gone from -0.8% in 2Q of last year to an expected -22% for 1Q24 (right in line with our RoC view). The stock hasn’t cared though as the market prepares for an eventual housing turnover recovery and potential fed cut to come. We think there is still risk to the company meeting 2024 expectations (coming in closer to 60 cents vs current 74 cents for consensus), but perhaps that doesn’t matter if earnings are still depressed for a unit grower that should comp when home retail finally recovers. Expectations have become super low for the next couple of quarters with the street expecting EBITDA down 43% YY in 1H, so potential for beats over the next Q or two, and the rate of change probably doesn’t get worse from -22% comps. So, we’re removing the ARHS short for now, we’ll potentially revisit around 2H should expectations be too high in the context of the direction of home retail at that point.
Earnings Previews
Adidas (ADS-GR) | Management Will Remain Positive, But We’ll Stay Bearish. It’s not a secret we’re broadly short the branded athletic space, and Adidas is no different. The setup for Adidas this coming year is tough, it's coming off two hugely profitable Yeezy drops in Q2 and Q3, as well as the hype of the fashion trend around the Samba and Gazelle. Yeezy accounted for around 750mm euros in revenue for the company this past year and was among its most profitable franchises. Adidas has dropped some of the roughly 300mm euro remaining Yeezy inventory in February, which will help the Q1 comp. The 300mm euros of inventory could be about 1bn euros in retail value. Selling the remaining Yeezy inventory will help comps this year, but it just means that comps next year will be tougher. The Sambas and Gazelle trend is holding in well, as the company releases new color ways and different collabs. For 2023, we estimate those styles to account for about 3mm pairs of shoes out of the over 400mm pairs Adidas sells annually. So aside from it being a small fraction of the total units sold, we don’t like to be bullish solely based on a fashion trend. For FY24 we’re coming out with EPS under €1.00 with the Street at €4.48. Even if our numbers are off by 100%+, the company is likely to see a big miss in numbers. It has sales headwinds over the upcoming year that it has to manage on top of the overall company dynamics. It has to be taken down to be built back up, and we have zero faith that the NEW CEO has the chops to get that done. The Street is building in margin expansion back to prior peaks from where it is today, but there is no real reason why EBIT margin should be higher than MSD, particularly given that it lost its most profitable franchise (steady state margins were about 7-8% pre-pandemic). Gross margins shouldn’t even be 50% given the fact that the company will no longer be selling Yeezy products, which carried the highest GM out of any of the products sold. The stock is currently trading at an over 50x PE multiple, but over a TAIL duration, with lower sales growth and lower margins, this company should be trading at a max 20x PE multiple – and we could argue low-mid teens – that of a dying athletic brand. Not only do you have a sharp downward earnings revisions cycle over a TAIL duration at Adidas, but likely multiple compression as well. The only plus here is that Adidas has already let the cat out of the bag that EBIT for 2024 is likely to be around 500mm Euros vs previous 1.2bn Euros. So the chance of a miss is low. But the algorithm is decelerating while the stock is trading at a peak multiple. Screams short to us.
Ulta Beauty (ULTA) | Weakness From Last Q Will Continue. We went short this name early, expecting the beauty category to crack sooner than it did. We’ve seen decelerations on revenue and earnings growth over the last four quarters, and for some reason the street expects an acceleration in the upcoming quarter printing Thursday night. Last quarter Ulta had EPS DOWN 5% and the Street is expecting them +13% in Q4, while earnings comps are slightly easier in the upcoming Q revenue is about the same. Let’s not forget that gross margins have been down-to varying degrees-for the last six quarters and weakening over the last two quarters. As the company continues to fight to maintain market share, it will continue to deploy promos and discounts. The company still expects shrink to be a headwind to margins this year as well. While traffic trends during the 4th quarter look okay at the beginning of the quarter, we see post-holiday into January down YY. The start of Q1 looks to have slightly improved, but still hovering close to flat YY. We think Ulta may have set itself up for a miss in Q4 as the P&L continues to degrade, and earnings expectations in the outer years are too high. Let's not forget the existential threat that Sephora poses through it's partnership with KSS. KSS is going all in on this one, and LVMH is not likely to let it fail. Nonetheless, there's ~80% overlap between physical locations, and price wars will step up materially in 2024. GM at ULTA is still 400bp above pre-pandemic, and we think the area where the Street will be wrong is that the company will compete this away to maintain share. At 15x EBITDA on a decelerating growth and profit algo, we see material downside here – potentially to sub-$400 (from current $540).
Dick’s Sporting Goods (DKS) | Print This Thursday, Still Leaning Short. This is not a pound that table short, as our last move on DKS was shifting it towards the bottom of our Short bias list on the margin reset event last year when the stock was around $112. It stayed on the short side of our ledger as we expected apparel and hardlines to see some demand reversion, while footwear likely continued to perform well given the elevated product flow into the section. Since then, the stock has rallied significantly as the company has been able to hold comp trends with numbers marching up some, and the multiple rallying to 14x. Visits at Dick’s are getting less bad, but still trending down ~10% in recent weeks. Golf Galaxy showing the worst visit trends we have seen in a long time, going negative in December and continuing to deteriorate. There are some elements of the DKS story we like… solid investments in its stores and the shopping experience. Again, footwear likely continues to comp up with elevated brands like Nike, Hoka, and On continuing to put more product on Dick’s shelves. Plus DKS is setup to be a share winner longer term as some regional competitors went away over the last decade, and many of the mom and pop sporting goods store have faded off over that same time period. However, there remains some things with DKS hardlines that we can’t quite wrap our heads around. The sheer amount of inventory across sports and across sports seasons perplexes us. Then in the sizeable golf section we see things like 4 generations of Callaway drivers (Maverick, Rogue ST, Paradym, and Ai Smoke) all on the rack at the same time, and all with different price levels. Then you have the below on the website, where clubs from 2019 and 2022/23 are listed at the same sale price. A quick check shows the 2019 club is available in 46 stores within 100 miles of us in CT. When do you have to heavily discount to clear out 2019 products and take the margin hit? What is the assumed carrying value of 3, 4, 5 year old inventory? It makes us think there is still either a margin event to come when writing off some of these hardlines items, or there is a pricing headwind on the horizon. Were looking at EPS around $11 to $12 a couple years out. Multiples across retail have gone up over the last 6 months. No reason to think this can’t trade at least the same as BBY in multiple terms, so ~13x perhaps? We’d perhaps discount that some with higher rates and our concern around category reversion. That would mean a stock of $120 to $150 vs current $181.
Kohl’s (KSS) | Watching the Credit Details This Week. We don’t have a call on KSS currently, but we think there is risk around the credit business for the company as it has some of the highest EBIT exposure to credit and some of the highest exposure to late fees as a revenue driver for its card portfolio. The retailers so far have been very cagey around quantifying credit and the risk that a late fee change could have on its credit business. We held a call with Hedgeye Financials Sector Head Josh Steiner to review the dominoes that are likely to fall as part of this CFPB late fee announcement. We walked through the timeline of when we might see the hit on retail P&Ls, and what the earnings risk might look like. Some of the more notable names with big private label credit card exposure in addition to KSS are M, JWN, DDS, BBY, TGT, GPS, and CURV among others.
Retail Credit Card Late Fee Fallout Replay Video Link: CLICK HERE
On Holdings (ONON – Best Idea Short) | There's a non-Zero chance that this will be the quarter that ONON blows up for us (to the downside). We're more likely to think it's a 2H event (while the rest of retail is in a better Quad environment). But unlike DECK, which we think will sell off multiple times – and wouldn't object to shorting after the first big decel in growth, as it won't be the last, we think you get paid on ONON all on one day. We think inventories are building again, discounting is apparent in the aged inventory, and the new inventory does not look too dissimilar to last season's product. We simply think this brand is growing too fast, and it's push into Wholesale distribution does not synch with its lack of product tiering and stratification. The same product available at DKS and FL is available on the ONON website, which is a flat-out reckless strategy. With Nike making a more aggressive push into Wholesale – because it desperately needs revenue growth – it is a risk for ONON that we think is underappreciated in a 24x EBITDA multiple. Brands with this growth trajectory simply do not avoid going through MAJOR hiccups – especially while scaling into new distribution. This story is riddled with risk. Knowing what we know today, we'd buy the stock in the teens, with it now trading at $34.
